For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

Vanguard is not an insurance company, but that doesn’t mean we don’t appreciate the potential value that some see in having a guaranteed income in retirement.
In fact, you may have heard that Vanguard recently introduced Vanguard Annuity Access™, powered by the Income Solutions® platform. This is an online annuity marketplace where you can compare quotes on comparable fixed annuities from a set of leading insurers. The program is designed to facilitate easy, apples-to-apples comparisons among different annuity contracts, with the highest degree of fee transparency possible. This new service may be very helpful to those people seeking the kind of income guarantees an annuity can provide.

There’s a lot to be said about annuities. They’re the focus of a great deal of attention in D.C. these days. And the amount of confusion that exists among consumers, policymakers, and even “experts” surrounding annuities and “lifetime income” is staggering. We won’t try to clear all of it up here, but we do have some thoughts to share.

To start, it’s important to clarify that when policymakers and academic economists talk about annuities, they generally mean “immediate life annuities” or “income annuities.” These annuities are insurance contracts in which you give an insurer a lump sum up front in exchange for that company’s promise to make regular payments to you as long as you live (or to you and/or an “annuity partner,” typically a spouse, as long as one of you is alive).

After you make this deal, you don’t have the option to subsequently “cash out” the policy and get your money back. An annuity provides essentially the same form of benefit you get from Social Security, or a traditional pension plan, except a private insurance company is the guarantor.

This type of annuity appeals to economists and policymakers because it can ensure that retirees spend their assets “efficiently”—where efficiently means maximizing the amount that can be spent and consumed while alive, on a risk-adjusted basis. In other words, many experts see the goal of retirement planning as enabling people to spend as much as they can (and as evenly as they can over time) while living, and then “die broke.” In this framework, dying with “extra” unused resources is a significant inefficiency.

Annuities and pensions eliminate this inefficiency because they’re designed to have zero residual value at death. If you die earlier than you’re expected to, whatever remains of what you paid to the insurer can potentially be used to fund payments to others who end up living longer. In theory, that means annuitants can have higher average income over their realized lifetime (on a risk-adjusted basis) than they could if they each had to manage their own spending through time. If you do it yourself, you always have to hold back at least a little on your spending in case you end up living longer than you expect you might.

For many reasons, annuities are less attractive in practice than they are in theory. For example, it seems clear that many people don’t consider leaving unused assets behind to be a complete waste. For those who don’t think leaving “extra” assets behind is a problem, life annuities aren’t an efficient solution. So the desire to leave bequests (or maybe more accurately, the lack of concern about “accidentally” leaving a bequest) may be an important reason for the lack of demand for annuities.

Even if people only care about what they’re able to spend while alive, there are other issues. One is pricing. On average, it’s been found that people who voluntarily purchase life annuities tend to live longer than the rest of the population. Hence annuity payouts must be set lower than they could be if “annuitants” had lifespans that matched the overall population. This has the effect of making annuities less appealing (i.e., more expensive) for anyone in poor health or with simply average life expectancy.

In addition, annuities are not unconditionally guaranteed, as they generally are in theoretical models. Insurers can and do go out of business, though there is a state-by-state back-up system (subject to limits and caveats). There are also some significant tax concerns and other issues like risk-sharing within families (for even more info, see the Vanguard white paper Understanding Income Annuities).

Perhaps most important, annuities are irreversible. Things change. Disasters occur and opportunities arise. Planning for contingencies is one thing, but adopting a financial strategy that extinguishes (or at least impairs) the option to do anything else has real costs.

All of these drawbacks need to be considered alongside the big benefit of annuities: They provide lifetime income, guaranteed by an insurance provider.

So should you be thinking about buying an annuity in retirement? Of course, most retirees already have some annuity income via Social Security. So the question really is: Do you want more annuity income?

If you believe that Social Security and other pension income provide too little low-risk, lifetime income, then our view is that you should seriously consider some level of additional annuitization. On the other hand, if you feel like you have a sufficient spending floor from other low-risk sources, you might stick with a prudent withdrawal strategy from a portfolio of assets. You can always look at the issue again later—as long as you preserve a significant portion of your assets.

Our view is that ultimately, annuitization is about deciding what absolute minimum income you want to ensure in retirement. Unfortunately, no algorithm can tell you that answer, and it’s a decision you must make yourself. For most retirees, rock-bottom minimum needs may be quite modest. In Washington, policymakers worry a lot about low-income retirees with limited resources running out of money. Yet for this segment of the population, a relatively large portion of retirement income will come from Social Security. This group may therefore have the least desire for additional annuity income. Demand for annuities could be highest among the relatively affluent, where Social Security’s guaranteed income provides a much lower “safety net” relative to what someone might need (or simply be accustomed to).

If you think you need more guaranteed income, it’s perfectly sensible to buy it over time – something like dollar-cost averaging into annuities can make sense. And diversifying among providers is a good idea too.

Investors face large investment risks in retirement—witness 2008–2009—as well as longevity risk, the risk of living a lot longer than anticipated, and other risks. At the same time, while an unexpectedly long life or poor markets could mean very painful adjustments, it’s possible to view painful adjustments in some circumstances as less consequential than giving up control of large amounts of assets in all circumstances going forward. It’s very hard, then, to say that low usage of annuities necessarily is “irrational” or a “policy problem.”

For most retired and retiring investors, who will be receiving a significant amount of secure income from Social Security, it remains to be seen whether the appeal of additional guaranteed income will trump control and flexibility, even in today’s challenging market environment. We expect that flexible portfolio-based solutions and gradual withdrawal strategies will remain the dominant way in which retirees access their retirement assets for many years to come.

Notes:

• Product guarantees are subject to the claims-paying ability of the issuing insurance company.

• Vanguard Annuity Access is provided by Vanguard Marketing Corporation and is offered in collaboration with Hueler Investment Services, Inc. through the Income Solutions platform. Income Solutions is a registered trademark of Hueler Investment Services, Inc. and used under license. United States Patent No. 7,653,560. Products may not be available in all states. Vanguard Annuity Access is provided by Vanguard Marketing Corporation.

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John Ameriks

John Ameriks oversees the Active Equity Group within Vanguard Equity Investment Group, which manages active quantitative equity fund assets. He is one of Vanguard's thought leaders on retirement issues and has conducted studies on a wide range of personal financial decisions, including saving, portfolio allocation, and retirement income strategies. John came to Vanguard in 2003 from the TIAA-CREF Institute, the research and education arm of TIAA-CREF. He graduated from Stanford University with an A.B. and earned a Ph.D. in economics from Columbia University.

Steve Utkus

Steve Utkus oversees the Vanguard Center for Retirement Research, which studies many aspects of retirement in America—from how individuals start saving and investing in the early part of their careers, to how they prepare for actual retirement, to how they spend down their savings once they’re retired. Steve is particularly interested in behavioral finance—the study of how rational decision-making is influenced by human psychology. His current research interests also include the ways employers design retirement programs, and new developments in retirement in other countries. Steve holds a B.S. from the Massachusetts Institute of Technology and an M.B.A. from the University of Pennsylvania's Wharton School. He began working at Vanguard in 1987 and has served as director of the Center for Retirement Research since 2001. Steve is also a visiting scholar at the Wharton School.

Comments

Richard G. | January 18, 2017 1:40 pm

Well Folkes If I want to know something about a subject(S.S.Life Insurance,annuities,medical questions etc. I think that I would go and ask a specialist about the field that I was interested in.Vanguard is not in the insurance business. they point out that various owners off Vanguard may be in need of more guaranteed monthly income.If that is one of your respective needs then the burden to find out about the particulars falls on you.I do not think we should fault John or any writer of Vanguard because they failed to give an answer to your specific question that you asked on a blog.All BLOGGERS must realize you are NOT going to get a specific answer to your question when Vanguard knows nothing financially about you.They are going to counsel a person who retires with 6 defined benefit checks differently than a person who has one $1500.00/mon S.S. but may own a 30 unit apt. complex generating %500,000./yrly income. What is one persons financial strength is another persons weakness.Once we have gotten the up to the minute info from our specialists then we can contact a Vanguard CFP, give them our financial particulars,what our goals are then they can appropriately guide you and help you manage your assets that will reach your goals.Mr Ameriks another thought provoking and informative article Your owners appreciate all of your blog writers.Let’s go and break into our 4th TRILLION under management in 2017!RG

Nba 2k16 Mt Wars H. | May 4, 2016 4:46 am

Emran A. | July 25, 2013 2:09 pm

Donald G. | February 2, 2017 10:42 am

To Emran A.7-25-13 2:09 p.m. Sir you were asking about annuities that were inflation protected. You can call up any Major Carrier and they will sell you a inflation protected policy. You can even tell them what % of protection that you want.But be advised that the higher up in protection the more it is going to cost you.If you have an employer retirement check and are drawing S.S. then you already have two annuities. Your S.S. check is inflation protected to the degree that the Congress raises the payout for S.S. recipients.Your employer check may or may not be. Before you retire you might want to meet with someone in your personel office and get familiar with your employer retirement benefits.You might want to call up Vanguard and give them your financial particulars and one of their CFP’s could help you co-ordinate all of your retirement checks and show you how to reach your goals. Good Luck in your retirement.

Anonymous | July 4, 2012 4:25 pm

I think the point made by the first commenter about a low interest-rate environment is important. As of 2012 we are in an extraordinarily low interest rate environment — historically low. If the insurance companies are relying on fixed-income investments to fund their annuity contracts, it seems to me they will have to charge a lot of premium to make up for the fact that their fixed-income investments aren’t producing very much income. If this is correct, then now is a VERY poor time to purchase an annuity.

Anonymous | April 16, 2012 7:44 am

I was glad to run across this most helpful article. I attended an Oak Harvest Session and then opted to get their information on an annuity. After reading your article I am glad that I have not committed to anything. I was finding it difficult to give up my hefty Thrift Savings Plan or rather my 401B. For now I think I will stay put.

Donald G. | December 22, 2016 8:55 pm

Mr. or Ms. Anonymous 4-16-12 7:44 a.m.I read your blog and I hope you have stayed with your TSP program.You did not reveal anything about your finances but if you are a TSP participant you must be in the military or are serving in the Federal government in some capacity.The TSP is one of the greatest savings programs on the face of the earth. I stuffed every thing that I could for over 35 years into this program.At retirement you can have your government check,an S.S. check which are the same as an annuity and in addition you can set up your TSP money with Vanguard( I changed all of my TSP to Vanguard at retirement) and have them send you another monthly check if you want to set it up like that. It is a great savings venue because of all of the employer matching you get.I have never had a problem accepting money from Uncle Sam. Good Luck in your retirement!

Anonymous | January 6, 2012 9:41 pm

I don’t trust annuities. Beware investment products that purport to guarantee ANYTHING. Back in the late 80’s, I had an insurance salesman sell my wife and I whole life insurance policies. Within 7 years, the dividends generated by the policy were supposed to be sufficient to pay the annual premiums. Well, that never happened. If the investments made by the insurance companies perform poorly – either due to their stewardship or just a bad investment climate in general – annuities will NOT pay as advertised. Don’t believe the “guaranteed” hype from the salespeople and companies peddling annuities!

Anonymous | July 2, 2011 2:34 am

I have considered annuities at several points in my recent quest for investment knowledge and alternatives. My constant conclusion is that the cost is much too high for the benefits offered and that the smoke and mirrors of some marketers of this product hide those costs very well. It took much effort and prying to weedle the actual costs out of more than one major provider. The total cost in each case convinced this investor that this vehicle is not for me.

Anonymous | December 21, 2011 2:43 pm

Yes you are correct about the costs ! Not only high maintenance fees with or without a benefit check as well as fees as a percentage of each withdrawl amount , and they are not reasonable ! Not an investment choice for me either, but how do I get rid of the one I have without severe penalties ???

Richard G. | June 24, 2017 10:48 am

Dear Ms. or Mr. anonymous usually when a policy is sold or set up for a client the policy will spell out the charges and pay out schedule. Most annuities are set up to have most of the heaviest charges front loaded into the payout.After about 5 to 8 years you will come out from under this front load and from then on you can disengage from the annuity as the insurance company has gotten their money from you and you should of course transfer everything over to Vanguard and start to make some real money for yourself.Call Vanguard up and tell them your financial particulars and they will be happy to help you set up a program that will help you reach your goals.Good Luck with your program

Anonymous | June 13, 2011 5:43 pm

I wish you had spent some time talking about taxes on money withdrawn from the Annuity. I keep telling my wife it is taxed as ordinary income, but she argues not so! She thinks only the capital gains and dividnds are taxed on the variable annuity. Any body want to answer that?

Anonymous | June 7, 2011 12:36 pm

The best annuity out there is social security. In my case I am 63 and I can get my full SS payment at 66. I was fortunate and maxed out my SS for about 20 years. For every year anyone waits to receive their SS you get another 8% up to age 70. That is a 32% increase if I wait the additional 4 years. In my case my payment at 66 would be $2,341 a month. At 70 I would receive $3,090. Social Security is supposed to be indexed to inflation. If that is the case the amount received at 70 would be much higher. Social Security is also taxed at a much lower rate than interest from an annuity, or regular income.. Another consideration is my spouse will get half of what I get as her social security is less than half of mine. Our combined SS payment would be $4,635 at age 70. If figure if one of us lives to 83 we will break even from taking it at 66. My wifes mother is 94 and still healthy. Upon my death my wife would get my SS which would give her over $3,000 a month from SS. Of course the problem is having enough money to live on if you delay payments.

There are some things you can do. After the first of next year my wife can file for her social security. That will be about $800 a month. I can sign on as her defendant and get 30% of hers now, or wait until I am 66 and get 50% or hers. She can switch over to mine when I take it. I have a large next egg, mainly in IRAs that I will use to live on for the next 7 years. My house is paid for. I have a rental house.

Anonymous | January 20, 2012 8:14 pm

to June7, 2011 at 12:36pm
Looks like no matter what you do you are set for life — getting a huge! social security payment and owning your house outright and a rental property…and you have even more inIRAs ….(our social security isn’t half what yours is).
But the rest of us have social security and only what we’ve saved in a tiny IRA and other savings…and small social security. Already with inflation and lousy .1%interest rates our savings are going down the tubes! and we are only 65.
Wish we could all be in your good shoes.

Donald G. | January 17, 2017 11:23 am

To Anonymous 6-7-11 12:36p.m.Dear Sir while I think that you have worked yourself and your wife into good financial shape, I would suggest you contact S.S. and get pertinent information.You stated that you maxed out your S.S. for 20 years.Your S.S. benefit is based on your highest 35 years of employment.Your increase in benefits is only 6.25%/yr from age 62 to your FRA(Full Retirement Age)for you is 66.From 66 to age 70 you do get a delayed 8%/yr. increase in your benefit.For every year that you show no employment under the 35 years you get a big fat ZERO and your benefit will be lowered.Also while you are in the S.S. office you may want to inquire about the new law that was passed last year which has changed your ability to file on one anothers account to increase your survivor and spousal benefits with S.S.One of the best benefits of S.S. benefits is that it is a lifetime benefit for you and your spouse but not one thin dime can be left to your heirs.On the other side of the coin is your 401k and IRA amounts can be willed to your heirs.Particularly when you only take the minimum out after 701/2 and let it grow during the early years.We should only make financial plans only after we have received sound and up-to-date information.This should also be carried over to being aware and familiar with any and all employer benefits we may have coming.My wife and I are both drawing S.S. at present and our eyes were opened when we delved into what benefits we were able to get.Good Luck

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.